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volatility

Our investing experience over the last two years vividly demonstrates the problem with confusing volatility and risk.

After years of relative stability, a certain security plunged by more than 80% in a few months. The standard model of risk would have you believe that the security was relatively safer at the high price level. And the more the price declined, the riskier it became—according to the standard methods.

Value investors seek the bargains. To them, the lower the price, the better the deal. This is exactly the opposite of the standard model of risk.

The rest of the story is that the security turned on a dime at the low point, and rose back to its original level in the following months. At the very point the standard model of risk viewed this investment in the worst light, it was preparing to embark on a rise of more than 400%.

There is a good reason why people (including professionals) confuse volatility with risk. In the short term, volatility IS risk. If you have wealth to pay the bills due within a few days, you cannot afford to have the value bouncing around from day to day. If it goes the wrong direction, you might not have enough money to pay the bills.

Therefore, whether volatility is risk depends on the time horizon. In the short term, volatility is risk. In the long term, perhaps volatility is opportunity, not risk. We work hard to understand your time horizon so we can get this right for you.

Clients, if you would like to talk about this in more detail, or have other things on your agenda, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

When we were small, some of us had older brothers who tried to convince us there was a monster under the bed. You may be surprised to know there is a corollary in the world of investing.

The monster promoted by some is generally called “the arithmetic of losses.” The arithmetic of losses is a simple mathematical observation that from a given number, if you take a certain percentage decrease, and then an equal percentage increase, you wind up lower than you started–even though your increase and decrease were proportionately the same. For example, if you start with $100, and lose 20%, you are at $80. If you gain 20% of $80, you’re still only back to $96. But we are here to tell you, there is no monster under the bed.

Consider that when a major stock market index declines by 50%, it then does need a 100% gain to get back to even. This is just arithmetic. But consider: whenever a stock market index is at an all time high, that is conclusive proof that the “arithmetic of losses” is a bunch of baloney.

Each all-time high means that the index has successfully come back 100% from every 50% loss, 50% for every 33% loss, 25% for every 20% loss… and MORE. Every time, every loss thus far. The long-term history of major United States stock market averages speaks for itself, and incorporates all the losses and all the gains.

Some fearmongers say investors cannot live with the ups and downs that are a necessary and integral part of long term investing. Clients, you know we work hard to ascertain whether you could be suited to our philosophy.

Part of that philosophy is that temporary declines, no matter how sharp, are not losses unless you sell out. It is not always easy, but it has worked out. No guarantees about the future, of course.

If you can be turned into a chicken, then some operator who claims to ‘control risk’ or promises short-term stability AND long-term returns may get your money. Please keep in mind that every chicken, sooner or later, gets eaten.

The fearmongers are right about one thing: markets go up and down. You and we know this. We work hard to manage the money you need without having to sell out at a bad time. This is one of the keys to being able to get through the downturns.

Clients, we are striving to find bargains, avoid stampedes, and own the orchard for the fruit crop. These principles will not prevent volatility. But there is no monster under the bed. Email us or call if you would like to discuss this or anything else at greater length.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Imagine a product that has these uses1:
• Vital part of every home and building.
• Goes into every vehicle; hybrids and electrics use up to four times more.2
• Needed for manufacture, installation and use of solar panels and wind turbines.
• Key requirement in making batteries.

One might imagine that demand for this product will rise in coming years, as technology changes our power grid and transportation, and the world continues to modernize.

Now consider the supply side. It takes billions of dollars and four years or more to create a new production facility. The industry that produces it went through a depression as prices for the product got cut in half from 2011 to 20163. Revenues disappeared, losses mounted, spending got slashed. New projects were cancelled.

Rising demand, constricted supply: we know how this works. Prices will rise, revenues and earnings for producers will go up, stock prices may follow. No guarantees, of course, and the timing is always uncertain.

The product is COPPER. There is no replacement for it. The question we face as investors is, can we get involved on a favorable basis?

We know companies that produce a lot of copper, along with other resources. Their stocks are traded on the New York Stock Exchange. The valuation on their shares seems compelling. A dollar of profit in one trades for a third less than that of the average stock; the other one carries a two-thirds discount. One is trading at one-third of its all-time peak a few years back, the other is discounted even more.

Both stocks have been about twice as volatile as the average stock. (This is measured by a statistic called ‘beta.’) We don’t care. Downside volatility is wonderful if you are trying to buy bargains. But owners should be prepared for the roller-coaster.

Clients, we are telling you this story for a reason. When you hear that ‘the market is too high’ or things are at some unsustainable peak, remember that at 228 Main, we are pounding the table and jumping up and down about the bargains we are finding. If you would like to discuss this or anything else at greater length, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Clients are familiar with our work in high yield corporate bonds. Since 2001, we have identified eight opportunities in the sector. We put more than $10 million to work by purchasing more than $20 million of bond face amounts at a discount, issued by these eight companies.

To be clear about the terminology, ‘high yield’ is a polite way to say ‘JUNK.’ Bonds do not sell for 70 cents or 30 cents on the dollar unless there are some issues that place the outcome in doubt. The conventional wisdom says that people should not purchase individual issues of junk bonds because of the risk involved.

This arena is a contrarian’s dream. We human beings know how to take things too far—it is one of the things we do best. To illustrate, when the price of oil fell from $140 to $100 to $60 to $30, the news was full of predictions that the price would fall to just $9 per barrel. Bonds issued by an oil exploration and production company fell to 30 cents on the dollar, then fell even more.

You already know we believe the crowd can be wrong, and the stampede is to be avoided. Our analysis of the company financial statements said that even if the oil company went broke, at $9 oil then bondholders would still probably recover 30 cents on the dollar in a liquidation. Since negative sentiment about oil prices had gone way too far, in our opinion, we concluded that oil was NOT going to $9 per barrel anyway.

Oil bottomed, the bonds bottomed, both rose. Clients, you noticed this in your 2016 statements. When we find an anomaly between what we expect will happen and what the market has priced in, profits may result.

What you do not see is the process by which we found the eight opportunities over sixteen years, and how we go about finding the next one. We recently found 199 high yield bonds offered for sale by 29 different issuing companies that met our first criteria. We seek 10% or higher yields, and 25% or greater discounts from face amount.

Smaller companies or issues of bonds that do not trade with sufficient liquidity are thrown out. Companies that lack an asset base from which creditors might gain a recovery are ruled out. And certain industries are judged too risky, based on the economic cycle.

The bottom line is, we need to understand how we would get our purchase money back even in the event of liquidation. If a bond issuing company ultimately cannot pay back the whole dollar, it goes broke. Creditors including bondholders get paid first, before stockholders. So if we buy in for 50 cents on the dollar and receive 75 cents back in a liquidation, we make money.

For each bond issuer, we need to understand the capital structure of the company. This tells us where the bonds rank in liquidation priority. We need to analyze the financial statements. What assets would be available for liquidation? Would the company make money if its debt was recalibrated to market value? We also must consider company management, and think about how well it would maneuver through a reorganization.

The title above says we work hard for the money. What we are talking about is the recent exercise where we looked at the 199 bonds of 29 issuers, went through our analysis to see if we could find a new opportunity…and came up empty. This is usually what happens.

We have looked at thousands of bonds issued by hundreds of companies over the years. Eight times in sixteen years, the stars lined up for us (and for you.) The search goes on, the next opportunity will pop up sooner or later. If you would like to talk about this or any other issue, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

The ability to adapt to changing conditions is what sets those who thrive apart from those who merely survive.

Our portfolio theory evolves over time as economic and market conditions unfold. The problem with the textbook approach in a changing world is that a textbook, once printed, never changes. Looking at the world as it is and doing our own thinking, we see things in a new way.

We believe that central bank intervention and counterproductive monetary policies have distorted pricing in the bond market and for other income-producing investments. By crushing interest rates and yields to very low levels, the old investment textbook has been made obsolete.

Therefore the classic advice about the proper balance between stocks and bonds brings new and perhaps unrecognized risks, with corresponding pockets of opportunity elsewhere. Yet the classic advice met a need which still exists: how to accommodate varying needs for liquidity and tolerance of volatility.

Our adaptation to this new world is the portfolio structure you see above. Our classic research-driven portfolio methods live in the Long Term Core. We believe our fundamental principles are timeless, and make sense in all conditions.

But people need the use of their money to live their lives and do what they need to do. So a cash layer is needed, tailored to individual circumstances.

The layer between is ballast. This refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast serves two purposes. It dampens volatility of the overall portfolio, thereby making it easier to live with. Ballast may serve as a source of funds for buying when the market seems to be low.

The client with higher cash needs or who desires lower volatility may use the same long term core as the one who wants maximum potential returns. One may want a ‘cash-ballast-long term core’ allocation of 10%-25%-65% and the next one 4%-0%-96%.

The adaptations we’ve made have generated efficiencies and therefore time—time to work individually with you on your plans and planning, time for more frequent portfolio reviews, time for more intensive research.

Clients, if you would like to discuss how this structure might fit your needs, please email us or call us.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Jeffrey Bezos founded the online retailer Amazon. He built it into one of the most revolutionary and valuable businesses on the planet. We are not here to discuss Amazon as an investment, but there is a key lesson for our clients in his explanation of this success:

“If everything you do needs to work on a three-year time horizon, then you are competing with a lot of people. But if you’re willing to invest on a seven-year time horizon, you are now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

The investment parallel is clear: just by lengthening the time horizon, you can live with the short term volatility that is inherent in the pursuit of long term investment results.

Those with a short time horizon—an insistence that market values be stable day to day or month to month—can generally expect meager returns. Stable values and liquidity both cost a premium, and if you want both you’re not left with much room for returns.

The ‘time horizons’ framework has interesting theoretical corollaries. It seems to us that investor time horizons, and tolerance for volatility, are smaller now than ever before. (This is an opinion based on anecdotal observation, not a fact.) But if this is the case, the competition for long term results is lighter than before.

Another aspect is that if the demand for stability is high, then the price of stability may be high—and the rewards for enduring volatility may also prove to be high since fewer are willing to do it. Again, this is based on our opinion, no guarantees!

By the same logic, we generally believe that investing in far-sighted companies rather than short-sighted companies makes sense. This is not to say that we are interested in pursuing every visionary out there—we know from experience that it is entirely possible to pay too much for a vision of the future, even if it does come to pass. But we are interested in long term results and prefer to invest in companies that share our time horizon.

Clients, we are grateful for you. As a group, you tend to understand living with volatility, and staying focused on the long term. We believe this has been good for you—and for us. Call or email if you would like to discuss your situation in more detail.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Wouldn’t it be great to have an easy job with a big salary? Or a hot sports car that was very low-priced? Or a luscious dessert with no calories?

The financial equivalent: an investment with good returns and stable value. Believe us when we say this is a popular concept.

Nearly five decades ago, the Rolling Stones advised that “You can’t always get what you want.” This is surely true of each of the situations described above. You just cannot get those desirable combinations.

But “if you try sometime, you just might find, you get what you need.” On the investment front, many people need their money to grow over time to meet long term goals. Stability of value along the way would be comforting to have. The true need is growth, and the key measure is how much money you wind up with in the distant future.

The real return on truly stable assets is usually low. Some people with a lot of assets relative to their needs can live with low returns. Most of our clients need their money working harder than that—so necessarily must forego stability along the way. (Or, adjust their goals to reflect more modest circumstances.)

We take pride in telling it like it is. Although many sellers promote the false notion that you CAN get good returns and enjoy stable values, we believe you can handle the truth. Markets go up and down—and that’s OK. Whether you were born with effective investment instincts or we had to train and coach you, many of you have shown the ability to live with volatility and invest effectively anyway.

Go ahead, ask us again about that mythical investment with good returns and stable value. We will help you understand that you can’t always get what you want, but you can get what you need. Call or email us if you wish to discuss your situation.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The field of medicine has a pair of terms that mean the same thing. The words describe an incredibly useful concept. The concept has important applications to the investment markets, and other economic and business usage. We were aware of the idea, but previously had no handy term to describe it.

The words are “cryptogenic” and “idiopathic.” They mean ‘of uncertain or unknown origin.’ For example, a cryptogenic stroke is one that has no known causative factors. Sometimes doctors know why something happened, other times they don’t. When they don’t, the diagnosis includes one or the other of these descriptions.

How would this apply to investing?

Every day at the market close, commentators speak or write as if they know exactly why the market did what it did. Despite the market averages being set by millions of people making billions of dollars in transactions for a nearly infinite variety of reasons, commentators boil it down to ONE REASON. “The market rose today over better-than-expected whatever,” or “The market fell today because of poor whatnot.”

We have said as many ways as we know how: the market goes up and down. It just does. To put it in more clinical terms, the market has cryptogenic rallies and idiopathic falls. The short-term action is of mostly unknown or uncertain origin.

According to Investopedia.com, in 1602 the Dutch East India Company issued shares that could be traded on the first stock exchange in Amsterdam. We suspect that at the close of trading on the first day, somebody said something like, “The market rose today because the tulips looked set to bloom early.” And this nonsensical tradition continues to this day.

If we accept the idea of cryptogenic stock market action day to day, we can focus instead on long term trends and fundamentals that may prove more fruitful.

Suppose that you owned a partnership interest in a business, and that your business partner was readily available any day to either buy out your half of the business or sell his half to you—as long as the price was right.

Suppose, though, that your partner suffered from erratic mood swings. He can quote you the price he’ll buy or sell for any time, but his appraisals are always colored by his current mood. When business is good he over-values the business and offers you the moon for your half of the business; when business is poor he becomes pessimistic and offers to sell you his share for pennies on the dollar.

This is a metaphor Warren Buffett uses in his shareholder letters to describe the stock market from the investor’s perspective, dubbing our hypothetical business partner “Mr. Market.” As a stock holder you have an ownership interest of a tiny slice in a business. There is a market to buy or sell shares of the business at almost any time. But the price the market may give you depends on investor moods.

According to Buffett, if you understand the value of a business it’s in your best interest to take advantage of Mr. Market’s mood swings to trade when his prices are at their most irrational. However, he also offers this warning:

“But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

So when the market is in a frenzy of buying or selling, there may be opportunities to profitably take advantage of the stampede—but not to join it.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk including loss of principal. No strategy assures success or protects against loss.

Warren Buffett may be the most famous investor in the world. The annual meeting of his company is known as ‘Woodstock for Capitalists,’ and is attended by 40,000 people. Countless articles, essays, and books have been written (including by us) about the things he has said.

As far as we know, nobody has ever written anything about things Buffett NEVER said. But here are our top three things Buffett never said:

1. “The stock went down, so I sold it.” Buffett knows the market goes up and down. He studies companies, not stock ticker symbols. When the fundamentals are in place, he buys. Then he holds. Then he holds some more. If the price declines, he typically buys more. This is what ‘buy low, sell high’ is all about.

2. “I’m waiting to invest until we get more economic data to clear up the uncertainty.” In his seven decades of investing, Buffett has noticed that uncertainty is always with us. He reads and studies ceaselessly, and when he finds something to buy, he buys it. Frequently, this turns out to be when the price is depressed because of temporary factors. Others are paralyzed by uncertainty when Buffett is taking action.

3. “A lot depends on what the Federal Reserve does next month.” Buffett has run his company for more than five decades, while seven different people held the chairmanship of the Federal Reserve Board, through innumerable cycles of Federal Reserve tightening and loosening. He can tell you what he paid for his stake in Coca Cola and when it was purchased. He probably cannot say what the Federal Reserve did at the meeting before, or the meeting after, the transaction. Why? Because it doesn’t matter in the long run.

Warren Buffett does not wear a halo. He is a human being and that means he makes mistakes. But he has made more money investing than any other human being on the planet. We think it pays to listen to the things that he has said. But there may be even more value in understanding the things he never said.

If you would like to discuss these concepts or your specific circumstances at greater length, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Stock investing involves risk including loss of principal.